Definition
The term exercise price refers to the price at which an option contract's securities may be sold or purchased. If the call or put option is "in-the-money," the difference between the exercise price and the market price of the underlying security is the potential profit gained per share.
Explanation
Also referred to as the strike price, the exercise price of an option represents the price at which the underlying security of an options contract may be bought by the holder of a call option, or sold by the holder of a put option. The exercise price is determined when the options contract is formed. The larger the difference between the current price of the underlying security and the exercise price, the greater the premium required to purchase the option (when first formed).
Individuals that invest in options pay close attention to the exercise price, since the difference between this price and the current market price of the underlying securities is what gives the option contract value. A contract that is in-the-money has real value to the investor; this can happen under two conditions:
Call Options: if the strike price is below the current market price of the underlying security, the holder can exercise their option and purchase the security at a price that is below market.
Put Option: if the strike price is above the current market price of the underlying security, the holder can exercise the option and sell the security at a price that is above market.
Related Terms
The term aggregate exercise price refers to the strike price of an option multiplied by the number of securities in the contract. The aggregate exercise price does not consider any premium paid, or received, on the option.
Moneyzine EditorJanuary 4th, 2024
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